Why slower manufacturing in Texas affects important ETFs

The Dallas Fed releases the Texas Manufacturing Outlook Survey for May

The Dallas Fed released the Texas Manufacturing Outlook Survey (or TMOS) results for May on Tuesday, May 27. The survey’s two headline indices, the Business Activity Index and the Production Index, both declined from April’s readings but stayed in positive territory. This suggests that both economic activity and output grew in May, though at a slower pace.

What is the Texas Manufacturing Outlook Survey (or TMOS)?

The Texas Manufacturing Outlook Survey (or TMOS) is a monthly survey conducted by the Dallas Fed to assess the state’s manufacturing activity. The survey asks respondents whether output, employment, orders, prices, and other indicators increased, decreased, or remained unchanged over the previous month. The results are then used to calculate an index for each indicator.

Each index is calculated by subtracting the percentage of respondents reporting a decrease from the percentage reporting an increase. When the share of firms reporting an increase exceeds the share reporting a decrease, the index will be greater than zero, suggesting the indicator has increased over the prior month. If the share of firms reporting a decrease exceeds the share reporting an increase, the index will be below zero, suggesting the indicator has decreased over the prior month. An index will be zero when the number of firms reporting an increase is equal to the number of firms reporting a decrease.

Output growth moderates

The production index dropped from 24.7 in April to 11 in May, reflecting slower growth in output. The capacity utilization and shipments indices also fell but remained above their historical averages. New orders plummeted to their lowest level in 2014.

Economic activity picks up over 2013

Businesses reported a less optimistic outlook for business conditions in May. The Business Activity Index fell from 11.7 in April to 8 in May, although this was still way higher than the reading last year.

The employment index dropped to its lowest level in almost a year, with both hiring and work week levels falling. However, employers continue to report wage pressures—a trend that has persisted since December. The seeming contradiction in employment trends suggests that highly skilled workers may be in great demand, resulting in upward wage pressure.

This month, the survey posed special questions to firms about their employment policies over the next six to twelve months. Over 48% of survey respondents expected to increase hiring over the period, compared to the only ~7% who reported that they would decrease their workforce. Of respondents, 68% also complained of having issues hiring qualified workers. About 71% of respondents said the chief hurdle for hiring qualified workers was a lack of technical competencies. About 49% of surveyed firms also reported a reluctance to pass on cost increases to customers, compared to ~32% who said they’d factor in labor cost increases in the prices they charge to customers.

Inflationary trends may be rising

Firms reported paying higher prices for production inputs and wages, although prices received for finished products fell. However, businesses expect upward price pressures for both finished goods and raw materials over the next six months. The trend for higher wages and benefits is also expected to persist.

In the next article of this series, we’ll discuss the manufacturing survey report issued by the Richmond Fed, which was also released on Tuesday. We’ll also discuss the impact of manufacturing survey releases on fixed income ETFs like the Vanguard Total Bond Market ETF (BND) and the iShares iBoxx $ High Yield Corporate Bond ETF (HYG), as well as industrial sector ETFs like the Vanguard Industrials ETF (VIS), which has holdings in companies like Danaher Corporation (DHR) and Honeywell (HON).